How would you model the impact of a sudden 200 basis point increase in interest rates on the debt service coverage and IRR of a buyout?

• A. Increase interest expense according to new rate, re-calculate DSCR and interest coverage, adjust debt amortization if required, and recompute IRR
• B. Keep debt terms constant
• C. Only adjust equity
• D. Decrease EBITDA

Answer: (A)

The key idea here is that a jump in interest rates directly changes financing costs and, through debt service, the cash flows available to equity, which in turn affects DSCR and IRR. When rates rise by 200 basis points, update the debt service by applying the new rate to the outstanding debt (and adjust any floating-rate components). Recalculate debt service, which changes the debt service coverage ratio and the interest coverage metric. If the higher cost makes debt service harder to cover, you may need to alter the debt schedule—for example, adjust amortization timing or consider a refinancing option within the model. With the new debt service and cash flow profile, recompute the IRR based on the updated equity cash flows and exit assumptions. This approach captures how rate shocks ripple through the capital structure to affect leverage metrics and investor returns. Keeping debt terms constant, only adjusting equity, or assuming EBITDA decreases, would miss the actual financial impact of the rate change on financing costs and the resulting profitability.